Kevin Taylor, director of the Bond Bank, said the city has little choice but to pay the penalty, which could total nearly as much as the utility's revenues in a year.
An immediate rate increase is necessary, Taylor said, because the nation's financial crisis has caused interest rates on the utility's debt to nearly triple.
Interest rates on that debt rose from 3.5 percent to 9.5 percent in the past two years, forcing the utility to make $20 million more in interest payments in 2008 than in 2007.
The Bond Bank had to come up with $14 million in January and will owe an additional $22 million July 1 if it cannot replace its variable-rate bonds with more stable fixed-rate bonds.
The water utility's $435 million in variable-rate debt represents 58 percent of its overall debt. Taylor said that amount is about three times higher than industry standards recommend.
The Bond Bank would have to make payments of $22 million twice a year for the next 10 years if it cannot fix the problem. That's money the city does not have, Taylor said.
O'Shaughnessy's report notes that the City got into this mess after it purchased the water company from NiSource for $515 million. The actual purchase price was much higher because Indianapolis had to assume $40 million in tax-exempt bond debt from NiSource and it had to capitalize the water company's operation. That's laying aside the more than quarter billion dollars in capital improvements the water company would have to undertake to properly maintain the company, improvements which had been neglected by NiSource. His report also neglects the fact that the City overpaid by at least double what the water company was actually worth. The names Bart Peterson and Beurt SerVaas, the two city leaders who brokered the deal, are noticeably absent from his report. So why did the City foolishly invest in variable rate bonds instead of the fixed rate bonds promised at the time of the water company's purchase? O'Shaughnessy writes:
In a presentation to the board in 2005, Bond Bank officials estimated they could save about $43 million over 30 years by refinancing $550 million in fixed-rate bonds. Staying with fixed-rate bonds would have saved $3.5 million in the same period.
"There was risk, but it seemed worth it," said Barbara Lawrence, who was director of the Bond Bank at the time. "Barring some event such as what we've seen, it seemed like a prudent decision."
Hoping to guard against the unexpected, the Bond Bank decided to limit its risk by entering into swaps involving Bear Stearns and other New York City financial firms. Bear Stearns has since collapsed.
In such swaps, two parties agree to exchange one stream of interest payments for another for a set period of time. The deals are supposed to protect bond issuers such as Indianapolis Water from violent swings in interest rates. The severity of the downturn, however, caused the bond markets to reel.
Lawrence, appointed by then-Mayor Bart Peterson, said she understood the risk and received sound advice from a wide range of advisers and attorneys. Good ratings from independent credit-rating companies confirmed the swaps were sound, she said.
"If I knew then what I know now, the deal would look different," said Lawrence, now the city manager of Speedway. "I made the best professional determination I could at that time. I accept that I can be second-guessed, but it's a reflection of what's gone on nationwide."
Notice who is taking responsibility for the mess--Barb Lawrence. I'm hear to tell you that she did not make that decision. Lawrence had absolutely no public finance experience that would warrant her appointment as head of the Bond Bank after Bob Clifford left that post to become City Controller. Prior to joining Peterson's administration, she worked at the Department of Administration where she helped administer procurement and state contracts. You can bet that Clifford instructed Lawrence to enter into these risky investments at the urging of the City's bond lawyers, which brings me to my next point. Where are the names of those bond lawyers who earned hefty fees on those bond transactions? Why aren't they mentioned? These are the same people who stand to make millions more off the water company as it is now forced to refinance all of that debt. The public needs to know who those bond lawyers were that advised the City on those variable rate bond transactions. As a penalty, those bond lawyers should be permanently barred from offering bond advice to the City of Indianapolis and Marion County. It is absolutely shameless of Clifford and these bond lawyers to sit by and watch Lawrence shoulder the blame for the decisions the big boys in the room who called all of the shots actually made.
UPDATE: A lot of you have asked who the other players in the variable rate bond transaction were. A review of the bond transactions on the Indianapolis Bond Bank's website reveals three bond transactions in 2005 for the Indianapolis Water Company bonds involving variable rate bonds, 2005F ($70,225,000), 2005G ($388,100,000) and 2005 H ($47,810,000). In each of those bond issues, Ice Miller acted as local bond counsel for the Bond Bank and the water company; Sommer and Barnard (Taft) acted as special counsel to the Bond Bank and water company on each of the transactions. City Securities served as co-book running manager with Bear Stearns. The transactions were insured by MBIA and Depfa Bank. Umbaugh, the CPA firm that hired Bob Clifford after he left the City of Indianapolis, served as financial advisor to the Bond Bank and the water company on each of the bond deals. Also, Baker & Daniels acted as bond counsel for the underwriters, meaning they were on the other side of the transactions. And just for the fun of it, it's worth noting that the person Mayor Ballard named as executive director of the Bond Bank is Kevin Taylor, who joined city government after leaving AIG's Global Investment Group. Yes, that's the same AIG of mega-government bailout fame. AIG's entry into the business of bond default insurance contributed to its financial mess. You just can't make up stuff this good.